NVE Corp (NVEC) 2014 Q3 法說會逐字稿

Good day, ladies and gentlemen, and thank you for your patience. You have joined the NVE conference call on third-quarter results. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will be given at that time. (Operator Instructions). As a reminder, this conference may be recorded.

I would now like to turn the call over to your host, the President and CEO of NVE Corporation, Mr. Dan Baker. Sir, you may begin.

Thank you. Good afternoon and welcome to our conference call for the quarter ended December 31, 2013, the third quarter of fiscal 2014. As always, I am joined by Curt Reynders, our Chief Financial Officer. This call is being webcast live and being recorded. A replay will be available through our website, NVE.com.

After my opening comments, Curt will present a financial review of the quarter and fiscal year to date. I will cover business items and we will open the call to questions.

We filed our press release with quarterly results plus our Quarterly Report on Form 10-Q with the SEC in the past hour, following the close of market. Both filings are available through our website.

Comments we may make that relate to future plans, events, financial results, or performance are forward-looking statements that are subject to certain risks and uncertainties including, among others, such factors as uncertainties related to the economic environments in the industries we serve, uncertainties relating to future revenue and growth, uncertainties related to future R&D contracts, risks related to developing marketable products, uncertainties relating to the revenue potential of new products, litigation risks, as well as the risk factors listed from time to time in our filings with the SEC, including our Annual Report on Form 10-K for the year ended March 31, 2013.

The Company undertakes no obligation to update forward-looking statements we may make.

We are pleased to report a solid increase in product sales and strong earnings for the quarter. For the quarter, product sales increased 12% and net income was $0.57 per diluted share. For the first nine months of the fiscal year, operating cash flow increased 17%.

Now I will turn the call over to Curt for details of our financial results.

Thanks, Dan. Total revenue for the third quarter of fiscal 2014 decreased 1% to $6.47 million due to a 97% decrease in contract research and development revenue, nearly offset by the 12% increase in product sales. Contract R&D revenue decreased due to the completion of certain contracts and contract activities. This continued to be a challenging environment for government funding but we are optimistic about future contract R&D revenue.

The increase in product sales was due to increased sales in the medical device market. Gross profit margin increased to 78% of revenue for the third quarter of fiscal 2014, compared to 73% for the third quarter of fiscal 2013 due to a more favorable revenue mix and a more favorable product sales mix.

Total expenses increased [to] 35% for the third-quarter of fiscal 2014, compared to the third quarter of fiscal 2013 due to an 81% increase in research and development expense, partially offset by a 5% decrease in selling, general, and administrative expense.

The increase in R&D expense was due to increased product development activities and a decrease in contract R&D, which allowed us to reallocate R&D resources to expensed R&D. We believe the investment in R&D will pay off in future revenues.

Interest income decreased 12% due to lower interest rates on our marketable securities. The provision for income taxes was a slightly lower percentage than the prior year quarter, 32.4% of income before taxes compared to 32.8% last year because of lower effective tax rates.

Net income for the third quarter was $2.78 million or $0.57 per diluted share compared to $2.9 million or $0.60 last year. The decrease in net income was primarily due to the large decrease in R&D revenue and large increase in R&D expense.

We are optimistic we can bring in more contract R&D revenue in the future, which would also tend to reduce expensed R&D.

For the fiscal year so far the first nine months of fiscal 2014, product sales were up 9%, and total revenue increased slightly to $20 million, as the increase in product sales was partially offset by an 83% decrease in contract R&D. Gross profit margin increased to 78% of revenue for the first nine months, compared to 74% for the first nine months of fiscal 2013 due to a more favorable revenue mix, a more favorable product sales mix and more efficient product manufacturing.

Net income for the first nine months decreased 2% to $8.57 million or $1.76 per share. The slight decrease in net income in the first nine months of fiscal 2014 compared to the prior year period was primarily due to the large decrease in R&D revenue and increase in R&D expense.

Operating cash flow or net cash provided by operating activities increased 17% to $9.82 million for the first nine months of the fiscal year compared to $8.42 million in the prior year. Purchases of fixed assets were approximately $34,000 for the first nine months of the fiscal year compared to $1.61 million for the first nine months of last year. Last year's investment was unusually high for us as we expanded and upgraded our production capabilities to support future growth.

With strong earnings and the completion of our expansion we generated excellent free cash flow. Free cash flow which is operating cash flow less capital expenditures increased 44% to $9.78 million for the first nine months of the fiscal year compared to $6.81 million the prior year.

We have also spent approximately $1.26 million in the fiscal year to repurchase shares of our common stock. As of December 31, cash plus marketable securities was $92.8 million, an increase of $7.58 million in the fiscal year even with the share repurchases.

Also of note are assets in shareholders' equity both crossed $100 million for the first time. This meant we had to add another digit to our balance sheet column but it is evidence of how far NVE has come in increasing shareholder value over the years. Total assets were $102.2 million and shareholders' equity was $100.8 million. When Dan and I joined NVE in 2001 shareholders' equity was about $2 million.

Now I will turn it over to Dan for his perspective on our business. Dan?

Thanks, Curt. I will cover R&D contracts, product development, and review some of our accomplishments in 2013.

Starting with contract R&D we are more than halfway through a one year National Science Foundation project grant titled Real-time Detection for Salmonella. The project is to develop biosensors for enhanced food safety in cooperation with the University of Minnesota and the University of Florida. The goal is to develop sensors with faster detection of foodborne pathogens than existing techniques while retaining sensitivity.

In the past quarter we made good progress in each of three key project areas: spintronic sensors, nano beads with aptimers, and microfluidics. We are also in discussions with food producers about their specific needs.

Despite a challenging government funding environment in the past quarter we were selected for the award of a Missile Defense Agency Small Business Innovation Research Phase I contract titled Spintronics-based Physical Unclonable Functions. The contract is for six months and approximately $125,000. A physical unclonable function. A physical unclonable function, PUF or PUF is a function that is embodied in the physical structure and it is easy to evaluate but hard to predict. The proposal is for Spin PUFs based on existing and future spintronics.

Possible applications include commercial high-speed encryption. A committee of government scientists, engineers, and technical managers recommended our proposal as a promising approach for the MDA. Our principal investigator is Doctor Joe Davies, who is recognized as an expert on anti-tamper technologies. There is a link to an abstract approved by the EPA for public release from the In The News page of our website.

Turning to product development we continue testing and development of controller area network couplers for in car networks and other applications. One of our key advantages is our products are half the size of conventional devices. Feedback from potential customers is the size is an important advantage. So, in the past quarter we began development of structures for even smaller parts which would be one fourth the size of conventional devices. We see automotive electronics as a promising large potential market.

In the past quarter, we expanded our new top-of-the-line coupler family with two new part types that contain four data channels. Four channel couplers are some of our most popular configurations for industrial control and factory automation. These new parts have a combination of best-in-class features for that market.

And finally, in the past quarter MV couplers were certified under VDE 08 84, a German gold standard for high-voltage performance of components of this type. This certification should be especially valuable in Germany and is also important worldwide for smart grid applications.

As we begin 2014, we look back on 2013 as a very successful year for NVE with new products, new distribution, and expansion. New products in the past year included current sensor samples, IL 800 series top of the line couplers, smaller network couplers, low-cost network couplers, and several new and custom medical device sensors.

In addition to developing new products, we upgraded several key product specifications to keep our products best in class. These specification upgrades were possible because of tighter process control and more mature manufacturing processes. Specifications that were upgraded included ruggedness specifications such as the ability to withstand high voltage for a very long time and to tolerate extremely fast high-voltage transients. We also specified lower power consumption on many of our products for improved energy efficiency.

New distribution in the past year included Newark element14 in North America, CFC electronic in Italy, IS Power in Turkey, and Shinji Technologies in China. Early in 2013, we expanded production capability including a new clean room bay. Finally, during the year, we deployed and optimize several new pieces of production equipment with goals of increasing capacity to enable future growth, improve our efficiency to reduce our product costs, and equipment redundancy for reliability of supply even if there are unanticipated equipment failures.

With that we will open the call for questions.

(Operator Instructions). Steven Crowley, Craig-Hallum Capital.

In terms of some follow-up questions on some of your prepared commentary, you mentioned some of the new products iterations and capabilities you've brought to market during calendar 2013 in the medical area and the industrial area and new segments of the industrial area. Can you flesh out some of the applications for these products that are real-world where you have had some traction at least start in acceptance of those products versus just where they might be able to fit?

We would love to hear the customer and the size of the market and all that stuff but you are probably not going to go there. Maybe we can put some meat on the bones of where you have seen some acceptance; at least the general neighborhood.

That's a great question, Steve. This is Dan. So, a number of the areas we mentioned, for example, our price-sensitive customers and the low-cost network couplers which were new products that we introduced in the past year. A lot of what those go into are modules that are interconnected so more and more modules and factory automation are being connected to central control systems. More and more automation, more and more robotics, more and more processes that used to be had to be done by people which are being done now by machines and equipment. More information coming back to the central control systems and this allows for more efficient factories, lower cost goods and we are especially seeing some traction on those types of products -- the industrial control factory automation in Asia.

Another area that I would highlight is energy management and energy efficiency. I mentioned that we had improved the energy efficiency specifications of a number of our products. What many people are using our products for is to improve the energy efficiency of their processes.

So, for example, things like factories, things like process control, process engineering plants where there are more and more sensitive to using energy wisely to save money and to reduce their carbon footprint. Our products are ideal for that because of the inherent low power that spintronics requires because there's no energy required to keep the products going. This only energy required at the transitional stage.

So, those are a couple of areas that I'd highlight but I think we were pleased with how things were going with the new products across the board.

And then in terms of medical, you mentioned some new custom sensors. Can you talk about some of the neighborhoods that those are pointed toward or are already in?

There are several areas. Probably the two most important are implantable medical devices and I think most of our listeners are familiar with our leadership in CRM -- cardiac rhythm management implantable devices. We are also gaining traction in neurostimulators. We have also gotten some good early design wins in non-implantable medical devices. These would be external medical devices where power consumption and reliability are very important.

As I think we talked about before, our strategy is to branch out from our traditional strength in life support medical devices into non-life support medical devices and I think we are making some very good headway in those areas; although it is somewhat early and sometimes those are fairly long design cycles. But we've gotten interest in new products. We have responded with new and custom products. In many cases our customers pay for those. That is an area -- the nonlife support medical device is an area that we see is very promising.

Is it safe to say while you have had design wins and definitive indication of growth prospects in those areas, their contribution really hasn't been all that noticeable in the past and maybe in the future? Or am I putting too many words in your mouth?

No. I think that's fair. When we are talking about new products in the past year these are early in the design stages. There's been enough interest from our customers that they were interested in customizing the product for their particular needs -- sometimes that's size. Sometimes that's electrical interface or other characteristics. That tends to be a high-value activity for us and it's a very good long-term business and I think it bodes well for the future.

In terms of your traditional businesses in customers, the December quarter can sometimes have that end of the year phenomenon as customers who want to lean out inventories look good at the report card stage. Was there that kind of phenomenon that you saw in your respective markets of medical and industrial? Was it notable or noticeable or not really?

Steve, this is Curt. You know, we really didn't see any evidence of anything unusual as far as customer inventories. As you had mentioned, the third quarter historically often is one of our weaker quarters that can be tied back to holidays and also some of our customers that shut down late in the calendar year. But I think, overall, we are pretty positive about future product sales.

Great. In terms of helping us understand two elements of the equation that are somewhat intertwined -- I will ask two questions, and then I will hop back in the queue. But the decline in contract R&D, that has been pretty breathtaking. I mean, you are down to pretty much nil.

But it sounds like besides hitting mathematical but now the mathematical bottom there are some improving prospects maybe with what's loosened up in Washington maybe with some of the projects that you have identified in pursuit and maybe even won at this stage, can we see a bounce back to at least a couple hundred thousand dollars a quarter in contract R&D pretty quickly? How should we think about that as an ongoing portion of your revenue mix for guys who get to try and model your Company?

Steven, it has still been a pretty challenging environment for government contracts but we are optimistic about future contract revenue growth from the most recent quarter, although probably not to the levels we saw a year ago. Dan did mention the NBA contract that we won that came in right at the end of the third quarter so that particular contract had not recognized revenue from yet. We are also pretty optimistic with some of the positive feedback we have received on some of the proposals. But I would say that we wouldn't see any potential new revenue until probably the first quarter of the next fiscal year.

Now in the intertwined part of this equation that I was going to ask about, R&D is much higher than a year ago. Part of that is the shift of resources from what would have been absorbed by that contract R&D into your own projects.

Is there any way to parse that such that we understand on an apples-to-apples basis what your NVE specific and directed R&D efforts are up year over year? Maybe it's just reflected in the number of square before there was a couple -- $300,000 that was reflected in the customer-funded activity or maybe there is that total number that you give us for the year -- the combination of the two buckets. I am just wondering in terms of your total capability, how much is really going on more than a year ago?

It's kind of hard to quantify. The R&D expense item that we show on our income statement, all of that is or the vast majority of that is related to internally funded research and development. Basically the cost for the contracts are primarily in the cost of sales line.

On an annual basis, Curt, you give us the number that's kind of the combination of NVE funded and customer funded R&D. I am just wondering if you were to total both of those buckets up in the third quarter whether it would look relatively comparable in total year-over-year -- just you guys bearing more of the brunt of it or whether or not you've kind of expanded your efforts and your footprints in R&D?

I don't have that exact number with me but I would say it's probably a little bit higher than last year -- the total R&D effort for internal and contract R&D.

That's helpful. I will hop back on the queue and maybe come back with a few more. Thanks.

Greg Greenburg, Wells Fargo Advisors.

I know you are hesitant to even update on the EverSpin litigation but at least can you remind us what's in the public domain as far as the last court date and what the next scheduled court date is?

The question about the EverSpin litigation, the lawsuit that we filed -- we filed a lawsuit against them. That lawsuit has been stayed, pending a patent office review -- what's called an interparties review of the patents until June. There's not a lot of court activity there.

There is a lawsuit pending also where EverSpin sued us and that is proceeding through the courts. We didn't give any -- there was no material update so there was nothing in our 10-Q about legal proceedings about that.

Okay. And then kind along a similar line, over the years we talk about sort of having this cash as a deterrent as well as to be able to defend yourself yourselves in exact cases on EverSpin and obviously last quarter -- the quarter just ended you did not buy back any stock. Correct? For the previous quarter you did?

That is correct. For the fiscal year we bought that a little over $1.2 million in stock for the fiscal year.

So cash and securities are now somewhere in $90 million?

Right. They are about $92 million.

And is there sort of a number that you feel the need to have as far as this warchest?

There is not a specific number. We do continuously look at how to best allocate capital to maximize long-term shareholder value and we talk about the buyback. We talk about litigation. We also think a strong balance sheet is important for the possibility of opportunistic acquisitions and for a hedge against contingencies. But we are always looking at how to best allocate capital so we will have to see. But we don't have any specific numbers that will trigger any particular actions.

I think you guys are doing a fantastic job. It's exciting to see the product revenue growth which is really what matters here, long term. It's the obviously a little bit mass by the time the contract R&D but you guys are doing a great job. Is fun to watch and hopefully we will see some sort of maybe stairstep function with some new products in the next few years. Thanks.

Thank you. We are certainly going to do our best.

Kevin Sonich, RK Capital.

That last question is a great segue into what I wanted to ask you about. Taking the contract R&D out of the mix and just looking at product revenue, you've often talked about it being unfair to look at just quarterly results. I think that's a fair way to think. That's a fair warning but in the last three quarters we have seen product revenue growth from as much is 38% to as little as -15% year-to-year. Even on a trailing full quarter basis over the last few quarters we have seen -7 to this quarter, if my math is right, 3% to 4% year-to-year growth on a trailing four-quarter basis. It should improve again next quarter assuming even if revenues are flat with last year it will improve a little bit I guess.

What I wanted to ask is I think it was Curt mentioned feeling pretty positive about future product sales and I know for you guys -- or I will make the assumption anyway for you guys that doesn't mean 3% or 4% product sales growth. I suspect it's well into the double-digit product growth, something more akin to what we have seen in the last six months on a year-to-year basis.

With that assumption I guess I am curious, what you think drives that? Is it mostly the existing product portfolio with perhaps some additional optionality the layered on top of that from some of the new products? Is it stuff that you have already started to sell, you have already commercialized and you are starting to see it ramp? Maybe things where you have been designed in but haven't started selling yet or even earlier kind of in the pipe -- an even earlier stage than that?

That is a good question. Not to dodge the question but it's a combination. Its existing products where we can grow with our customers. It's new products. It's winning new design wins from new customers to us. We talked about, for example in answer to a previous question, about design wins that we have been new and customer medical device sensors. That's a new area that will build over time.

Sometimes these things take a while but we are already seeing results from new products. We have had a very successful year for new product introductions. I mentioned some of them in the prepared remarks. We are starting to see some of the results from that opening up new markets or sub markets to us, opening up new customers and applications with our new products. Some of them are incremental but some of them are really quite dramatically better products or different products.

So, it's a combination of things -- we look both at the near term and the long term. We believe both are important.

So, we are looking at markets that have various stages and various lengths of design cycles. And we think that with the latter of those that we are going to build a strong foundation for growth. We have already seen results of that as you mentioned in the second half of the calendar year.

Thanks for that. Without any kind of blockbuster developments -- something like maybe the sensors on the food safety side or the auto market really opening up, understanding those are all very real opportunities and you wouldn't be pursuing them unless you thought you could make strides there. But if we take that off the map just for a second and we look at the existing product portfolio, including some of the new products that you have launched recently and some of the new markets or submarkets you got into already, can that alone start getting us back into the growth rates on the product side? Maybe not all the way back to what we were seeing a few years ago but at least well back into something that I think you guys strive for. Is it well into the double digits or to be need one or two of these new opportunity sets to really take off?

Kevin, as you know we typically don't get into specific numbers or growth rates but the way I would characterize it is our goal for the existing products and some of the new products that we have that are in existing markets is that that can fuel significant growth. That's the goal. Our goal is always to significantly outperform our competitors and outperform our industry.

Then we feel we have some excellent opportunities to open up significantly bigger markets than the ones we serve now. We see very good growth potential with our existing portfolio. As I said, we believe it's best in class. We are continuously improving those products and we made significant improvements in the past calendar year.

Then, we see a number of opportunities that we have talked about that could significantly -- that could fuel significant growth where some of those markets are much bigger than the markets that we currently serve. We think we have excellent potential, as I mentioned, in the near term and an opportunity to truly revolutionize the industry in the long term.

Okay. That's helpful. Thanks, Dan.

Steven Crowley, Craig-Hallum Capital.

As promised, coming back with a couple of more. In terms of the partnership you referenced over the past year or so with a major global semiconductor company that lays the groundwork or at least puts you on a path to penetrating the in car network market. The in-car device market versus just being in the automotive factory. Can you give us a sense for whether or not you are making forward progress down that path and how long that path is likely to be as you have gotten more educated about what it takes to be in that market place the way you want to be in that marketplace?

Yes. We are making good progress on getting into that particular product that we talked about -- it's controller area networks, which in particular we are targeting hybrid electric vehicles. I think this calendar year is going to be an important year for that. I think we are going to start seeing design firm up for the next generation of hybrid electric vehicles and we want to be an important part of that. We believe we have convincing benefit position with advantages in speed, power, reliability, and size. We talked about size in the prepared remarks. We are working on -- our products that are currently half the size of conventional products and we are working on platforms to make them a quarter of the size. That would be an even more significant advantage.

We are also pursuing some other opportunities in the automotive in-car electronics and conventional 12 V vehicles. Those might have some potential near term. They probably aren't as sweeping as some of the potential we see in hybrid electric vehicles but we are seeing a number of opportunities to improve efficiency in cars and we see that as a very important market for us.

Can I infer from the good tone and tenor of those comments that your relationship with that partner who has a good presence in the car market has continued to develop and progress or at least be in good stead?

Yes.

In terms of the food safety capability or to food diagnostics pathogen detection stuff that you started to talk to us about. Can you talk to us maybe a little bit about the unique capabilities or the novelty novel capabilities you are trying to develop or validate in this work and if you are successful, what your commercialization strategy might look like? I trust maybe given that you are not in that market that a partner would be necessary. How early are we in that equation of starting to develop potential partners?

The goal in this project would be the one-year projects which would be concluding mid calendar year. The goal there is to demonstrate faster detection the foodborne pathogens in line or in-stream detection. So it would be very close to real time while retaining the existing sensitivities so they tend to be a trade-off between speed and sensitivity, sensitivity being the level of pathogen that can be detected.

Our goal is to have a significantly faster system. The progress that we made in the past quarter was that have now combined spintronic sensors with nano beads, then microfluidics in a prototype or a breadboard and we are now testing that and the next step would be to integrate that with the biologics -- the aptimers.

And our goal is to be able to demonstrate that faster speed and that in-mind capability at the conclusion of this program about mid calendar year. I also mentioned that we are in discussion with the producers. We believe that we can partner directly with food producers. Many of them have a great deal of capability in-house and food safety is, as you can imagine, very important to them. We happen to be in a major poultry producing state here in Minnesota. It's a very important part of the state economy and food safety is very important to them -- to our potential customers.

So, we have had discussions about customizing these products and bringing them to commercial versions that will meet the need for the specific needs of these potential customers, primarily large food producers. So, we see it as a technology where we have some of the key technological capabilities in the sensors. We have partnerships in the areas where we don't have capabilities, so the nano beads, the microfluidics and the aptimers or biologics. We believe we have good relationships with potential customers -- the wholesale food producers.

Great. Thanks for answering the question. There was some really good color there. We will talk to you soon.

Thank you and at this time I would like to turn the call back over to Mr. Baker for any closing remarks.

Thank you. We reported a 12% increase in product sales for the quarter, 17% increase in operating cash flow year to date. We continue to see a bright future for new product as we discussed and we look forward to speaking with you again in early May to report our results for the full fiscal year. Thank you for participating in the call.

Thank you, sir and thank you, ladies and gentlemen, for your participation. That does conclude your program. You may disconnect your lines at this time. Have a great day.